Properties of the Margrabe Best-of-Two Strategy to Tactical Asset Allocation

International Review of Financial Analysis, Forthcoming

26 Pages Posted: 6 Dec 2017 Last revised: 31 Dec 2018

See all articles by David Ardia

David Ardia

HEC Montreal - Department of Decision Sciences

Kris Boudt

Ghent University; Vrije Universiteit Brussel; Vrije Universiteit Amsterdam

Stefan Hartmann

Finvex Group

Giang Nguyen

Vrije Universiteit Brussel (VUB)

Date Written: November 30, 2017

Abstract

The Margrabe Best-of-two (MBo2) strategy is a rule-based dynamic investment solution for the two-asset allocation problem. Its typical implementation involves yearly rebalancing the portfolio weights to 50-50 between a high-risk and low-risk asset. It uses intra-year weight adjustments to chase the momentum of the best performing asset by replicating the value of a Margrabe option to exchange an asset for another asset. In practice, this means that the Margrabe portfolio allocation benefits from the upside potential of the high-risk asset and the downside protection from the low-risk asset. The MBo2 allocation depends on the assets' prices, their return volatilities and correlation, as well as the remaining time until year-end. In this paper, we derive analytical formulae and use simulations to provide insights on the sensitivity of the strategy's weights and performance to these input parameters. We also report the results of an extensive out-of-sample evaluation for the bond-equity investment problem.

Keywords: Best-of-Two, Bond-Equity, Margrabe, Tactical Asset Allocation, Upside Potential, Downside Protection

JEL Classification: G11

Suggested Citation

Ardia, David and Boudt, Kris and Hartmann, Stefan and Nguyen, Giang, Properties of the Margrabe Best-of-Two Strategy to Tactical Asset Allocation (November 30, 2017). International Review of Financial Analysis, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3081036 or http://dx.doi.org/10.2139/ssrn.3081036

David Ardia

HEC Montreal - Department of Decision Sciences ( email )

3000 Côte-Sainte-Catherine Road
Montreal, QC H2S1L4
Canada

Kris Boudt

Ghent University ( email )

Sint-Pietersplein 5
Gent, 9000
Belgium

Vrije Universiteit Brussel ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

Vrije Universiteit Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Stefan Hartmann

Finvex Group ( email )

Arenbergstraat 44
Brussels, B-1000
Belgium

Giang Nguyen (Contact Author)

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

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